On Friday, the latest release
For some, showed a modest decrease
In pace of inflation
Although observation
By others was not of that piece

 

As an indication of just how confusing everything is in the macroeconomic world, and how earnestly different pundits try to make their individual cases, the following two headlines were in the same email roundup of market and economic articles that I receive daily.

The Fed’s Favored Inflation Gauge Reinforces The Disinflationary Trend

Federal Reserve Watch: Inflation Not Dropping

Parsing a specific data point that is subject to so much revision is always a fraught activity, and this time is no different.  Did the PCE data Friday indicate the inflation trend is starting to head back down or not?  Beats me. Below are the forecasts and actual results as released Friday morning by the Bureau of Economic Analysis (BEA).  While the M/M Core PCE print was a tick lower than the consensus forecast, everything else was right there.  If anything, the fact that Personal Spending fell ought to be a bigger concern.

Source: tradingeconomics.com

So, ask yourself this question, based on the information above, is the disinflationary trend being reinforced?  Or is inflation still sticky and rising?  Personally, I don’t think we have enough information to have changed our views from whatever they were ahead of the release, but that’s just me.  If nothing else, perhaps this will help you understand just how little anybody really knows about the situation.  One other seeming anomaly is that the M/M Core PCE number was lower than expected, yet the Y/Y number was right on target.  Whatever your null hypothesis, it doesn’t seem as though there is enough new information in this report to reject it.  Of course, that didn’t stop the punditry!

In Mexico, voters have spoken
And Claudia Sheinbaum’s awoken
This morning as prez
From Roo to Juarez
Alas, now the peso’s been broken

In a historic, although completely expected outcome, Claudia Sheinbaum has been elected president of Mexico, the first woman to hold the office.  She is current president Lopez Obrador’s protégé as well as the former mayor of Mexico City.  Now, she will be ruling from Quintana Roo in the south to Ciudad Juarez in the north of the country.  However, perhaps the bigger news, at least from the market’s perspective, is that her party, Morena, looks like it will win a supermajority in both the House and Senate there.  This matters because it will allow congress to alter the constitution as they see fit with no checks against it.  Given that Morena is a left-wing party, markets have suddenly become concerned that there could be serious impacts to the nature of business in Mexico which might impact both strategic and operational questions.
 
Consider, part of Mexico’s attractiveness as a manufacturing base was its relatively low wages.  However, with this type of political control, it is not hard to believe that a much higher minimum wage would be imposed, perhaps only on companies that export goods, but one that would substantially reduce the profitability of those operations.  As well, changes in the constitution would now be achievable with no recourse.  Reduction of judicial independence and the removal of the presidential term limit are two key domestic issues that may be addressed and are garnering concern.  After all, the one thing we all know is that when one political party can change the rules without the opposition having a say, those rule changes are generally designed to maintain power in perpetuity.  History has shown that is not typically a great situation.
 
As to the market impact, under the rubric, a picture is worth 1000 words, behold the chart of the peso as of this morning.

Source: tradingeconomics.com

FX traders and investors have determined there is a great deal of risk attached to the overall election outcome, and the peso has suffered accordingly.  This morning it has fallen -2.6% and is showing no sign of slowing down.  Remember, the peso has been a favorite currency in the hedge fund world as the carry trade has been a huge winner since last October.  Not only did traders benefit from Mexico’s higher interest rates, but the currency appreciated nearly 10% as well from October through late May.  But as of this morning, MXN has weakened nearly one full peso from its level just two weeks ago.  I sense that many risk managers are forcing a lot of position unwinding as the broader concerns over the future direction of the country increase as per the above issues.  For those of you with MXN revenues or assets, this will be a tricky time as hedging remains very expensive.  For those with MXN expenses, flexibility will be key with option structures likely to be very effective right now.

However, beyond those stories, the overnight session was relatively muted.  PMI data was largely in line with expectations around the world, confirming that economies are not seeing either significant growth or weakness, but rather muddling through.  So, let’s see how markets behaved overall.

Friday’s late US rally was followed throughout Asia with the Nikkei (+1.1%), Hang Seng (+1.8%) and ASX 200 (+0.8%) all having solid sessions but pretty much all markets rallying overall.  European bourses are also having a good day led by the DAX (+0.85%) and Spain’s IBEX (+0.8%) with green being the dominant color on screens here as well.  US futures at this hour (6:45) are pointing higher, except for the Dow which is down ever so slightly.

In the bond market, yields are continuing their recent slide with Treasuries down 2bps this morning and 15bps from the levels seen just last Wednesday.  European sovereign yields are also lower this morning, but between 4bps and 6bps as it appears traders remain highly confident the ECB, which meets Thursday, will cut rates by 25bps despite last week’s firmer than expected CPI data there.  The fact that the PMI data was lackluster has probably helped this mindset.

In the commodity markets, oil prices have edged higher by 0.1% after OPEC+ laid out that they will maintain production cuts through 2025, but also created a process by which they would eventually grow production again.  Given the fact that there is no indication demand for oil has peaked, I expect that all that production and more will ultimately be needed.  In the metals markets, both precious and industrial metals are continuing their modest rebound after the recent selloff.  Of course, given the strength of the rally since March across the board here, more consolidation seems quite likely for a while.  However, I believe the direction of travel remains higher for all metals going forward.

Finally, in the FX markets, while the peso is the outlier, (now -3.4% just 45 minutes later than the earlier update), the dollar is mixed otherwise.  ZAR (+0.6%) is benefitting from the news that a coalition government is forming, and Cyril Ramaphosa is likely to remain president.   Meanwhile, KRW (+0.5%) rallied on the back of stronger PMI data.  However, the euro (-0.1%) and its CE4 acolytes are all softer this morning as there has been more saber rattling over Ukraine’s use of recently acquired long-range missiles and ammunition from the West to attack deeper into Russia.  Threats are now being made about an escalation of this conflict in terms of the sphere (i.e. Eastern Europe) and the tools (i.e. nukes), so the euro is feeling a little heat.

On the data calendar this week, there is a decent amount of new information culminating in the payroll report on Friday.  As well, we hear from both the Bank of Canada and the ECB this week.

Today	ISM Manufacturing	49.6
	ISM Prices Paid	60.0
Tuesday	JOLTS Job Openings	8.34M
	Factory Orders	0.6%
Wednesday	ADP Employment	173K
	BOC Rate Decision	4.75% (5.00% current)
	ISM Services	50.5
Thursday	ECB Rate Decision	4.25% (4.50% current)
	Initial Claims	220K
	Continuing Claims	1798K
	Trade Balance	-$76.0B
	Nonfarm Productivity	0.3%
	Unit Labor Costs	4.7%
Friday	Nonfarm Payrolls	190K
	Private Payrolls	170K
	Manufacturing Payrolls	5K
	Unemployment Rate	3.9%
	Average Hourly Earnings	03% (3.9% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.7%
	Consumer Credit	$10.5B

So, lots to look forward to all week with two key central bank rate decisions and rate cuts seen as the most likely outcome.  As well, the payrolls will be a critical piece of the Fed discussion.  But mercifully, the Fed is in its quiet period so there will be no actual Fed discussion.

Last week, investors and traders got excited over the prospect that inflation was heading back toward target which would allow the Fed to finally cut rates.  However, that interpretation seems tenuous to me, as I do not see the data as pointing strongly in that direction.  Given it seems likely that both the BOC and ECB will be cutting rates, Friday’s data will be extremely important in helping us determine the tone of the FOMC meeting.  I believe we are seeing a growing split between the Fed governors and regional presidents with the former anxious to start easing policy while the latter see that as quite risky.  My take is that split will prevent any actions for quite a while as both sides argue their case and so any rate cuts will not be coming until next year at the earliest.  That is, of course, unless we see a significant economic downturn, which seems highly unlikely right now.  In the end, I think the dollar will maintain its value overall as the Fed remains the most hawkish central bank around.

Good luck

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